IMAGINE YOUR portfolio lost 25% last year. To recoup that loss, you would need to earn not 25%, but just over 33%. You can show this mathematically as:
0.75 x 1.3333 = 1
The larger the investment loss, the harder it is to climb out of the resulting financial hole. If you lose 50%, you need a 100% gain to get back to even. What if you lose 75%? To make back that loss, you would need to earn 300%.
This is the reason that volatility is so damaging to investment compounding. While the occasional losing year is almost inevitable if you invest in the stock market, you should be leery of pursuing a strategy—like buying stocks with margin debt or purchasing leveraged exchange-traded index funds—that can result in large losses, because you need huge gains to recover from such losses.
Previous: Rule of 72
Blog: Mistakes Compounded